January 16, 2011

Weighing the Week Ahead: All Eyes Turn to Earnings

In the near term, the two most important market questions are the following:

Will corporate earnings continue the consistent strength of the last eighteen months?

How much of this has the market already anticipated?

To understand the importance of these quesitons it helps to look at how well companies have done in recent quarter. Bespoke Investment Group's charts have a way of combining simplicity with a powerful message. This chart of the "beat rate" is no different.

The BIG team notes that the historical "beat rate" is 62.5%, so we are on a six-quarter streak. The full article shows a list of key companies and how to get additional information. Check it out if you want to be ready for earnings season.

I have written quite a bit about earnings, noting weekly that the "dog has not been barking." We have not had a slew of negative pre-announcements, so readers may well guess my own answers to these questions in the conclusion. But first, let us do our regular review of last week's data.

Background on "Weighing the Week Ahead"

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. Others will disagree. That is what makes a market!

Last Week's Data

The economic data flow picked up last week. The picture was mixed, with a negative lean.

The Good

Major economic indicators continue to beat expectations.

Economic growth is improving. The ECRI weekly leading index had a small decline last week, but the growth index, now in positive territory for a third week, is at a 33-week high. The ECRI said several weeks ago that a near-term recession was off of the table. Each week we have more evidence that they are correct. Investors should think about the growth index as an acceleration term, while the WLI is a level. The bearish punditry focused on the acceleration term when it was negative. Please check out this interview to contrast the ECRI posture with outsiders trying to interpret their data, especially David Rosenberg. The current ECRI verdict? "With WLI growth rising for ten straight weeks to a 33-week high, U.S. economic growth will soon begin to revive," said Lakshman Achuthan, managing director of ECRI.

Risk as measured by the St. Louis Fed Stress Index, edged slightly lower, remaining at a very low level. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to .122, down slightly from .163 last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods.

I have run this chart for several consecutive weeks for an important reason. I know that many people who need wealth creation, not wealth preservation, are worried about another 2008-style collapse. I suggest this indicator as a way of sharing in stock market gains while keeping safe. I am not planning to run this chart again, although my team is doing an analysis of this and related indicators in a "best times to invest" study.

Portugal successfully sold some debt, which had a calming effect on the markets.

Hiring plans are improving. Almost one-quarter of employers — 24% — said they plan to hire full-time, permanent workers in 2011. That compares with 20% this year, and 14% in 2009, according to CareerBuilder.com’s survey in late November of more than 2,400 hiring managers and human-resource professionals.

The trade deficit was lower. In the complex GDP calculation, this means that GDP will be higher.

The Bad

The bad news grabbed my attention this week.

Initial jobless claims spiked higher, rising by 35,000. This series needs to get well below 400K for a real jobs rally. Regular readers know that I view this series as an important input in the analysis of employment trends. There is a lot of skepticism about the data. This surprises me, since it is one of the cleanest and most frequent reports. This take on seasonality and government honesty from Edward Harrison was something I found to be especially helpful.

Retail sales were el stinko, up only 0.5% instead of the expected 0.8%. No weather excuses allowed...

University of Michigan Sentiment was only 72.7 -- another good employment indicator, and a significant miss from expectations and last month.

CPI and PPI moved higher, especially the non-core rates. This is something to watch carefully.

The Debate Club

There are two issues in front of the Debate Club.

Is Sentiment a major risk? For several weeks there has been a consistent (and losing) proposition that sentiment was too bullish. I entered my own objection. This week Prieur du Plessis noted something that I have also observed -- a disconnect between reports like AAII and what he was hearing in his private contacts. He ran a poll on his site, and also at Barry's. The official results have not been announced, but as a voter I can tell you that it is not overwhelmingly bullish. The idea that people are "all in" already is just silly.

Is the economy improving? The main consensus of economists recognizes the improving data that I have cited here for many weeks. Various economic polls reflect the improvement. There is a minority viewpoint suggesting that this is supposed to be bad news --- that these were all of the people who did not "forecast the crash." This is a subject that requires a separate article, but I want to make a preliminary observation. Most readers do not look at the long-term records of those who "forecast the crash."

Our Own Forecast

We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. Felix has captured the big rally since last September, usually in the best sectors. The ratings are showing more of a mixed tone. It is a close call, but we are continuing our bullish position in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

61% of our 56 ETF's have a positive rating, down from 88% last week.

48% of our 56 sectors are in our "penalty box," up significantly from 21% last week -- a warning.

Our universe has a median strength of only +7, down from +18 last week, and continuing a decline.

The overall picture is much weaker. While we maintened a 100% long posture, we are watching the indicators quite carefully.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

The coming week will be shortened by a holiday and will also feature options expiration.

For me, the earnings story is paramount. Congress will be back in session with political posturing at the forefront.

As usual, I like building permits as the most useful of the housing data.

Joe Weisenthal thinks that Thursday's data about China is "the only data point that matters." OK. I respect Joe's opinion, so let us keep an eye on China -- obviously important.

My own sense is that the bearish punditry has created a long list of foreign countries for a weekly check. If it is not perfect, they predict disaster.

Investment Conclusion

As an investment manager I try to find the best prices for new investors, often hoping to "buy on dips." The current market is not offering many such chances.

Turning back to the questions from the start of the article, I think the answers are pretty easy. I have been writing for weeks about the "dog not barking" -- the absence of negative pre-announcements. I have also warned about people confusing their political viewpoints with a dispassionate analysis of corporate earnings. I also wrote about the successful prediction of forward earnings by analysts.

Those following me have captured the rally in these weekly articles, but I have also done something else.

I have added a focus on risk!

I got some help on this -- feedback from regular readers (like Mike C.) These readers may not all agree with my risk measure, but they inspired the work. More to come on that front. I always appreciate and learn from reader comments.

To be clear, I think that the market is significantly undervalued. The overall market multiple will move higher as the palpable fear is reduced. There are many great stock choices. (I am not legally allowed to advertise performance, but our contrarian portfolio has a stunning start for the year, and we are nowhere near our target values for the stocks). For most individual investors it is a question of how to participate in the market, while controlling risk.

Most of the investment advice you read does not emphasize the right starting point: Begin with your personal needs! That is more important than the market.

Meanwhile, many people have missed the big rally because they did not grasp the most fundamental concept of market valuation: Earnings. Check out this colorful analysis from the Pragmatic Capitalist:

Markets do not care about you. They don’t care about your family, your feelings and they particularly don’t care about your wallet. With record deficits, QE2, 9.4% unemployment, continuing stimulus and 0% interest rates many are still baffled by a surging stock market. What gives says the Main Street investor? Clearly, there’s still an enormous disconnect between the market and reality. I know, there are a lot of positive signs out there, but the fact remains – Main Street still doesn’t feel like the recovery is headed their way. But the market isn’t the economy. Main Street isn’t Wall Street. And the market is a heartless beast that desires one thing and one thing only- PROFITS!

Explaining the same story in a different way is the must read weekly chart video from Charles Kirk. He starts with some music...."I fought the law..." For readers of a certain age, that almost tells the story. Too many investors have gotten involved with what they think government policy should be, instead of figuring out how to accept reality and to profit.

For traders, it is a bit different. The indicators are more mixed -- almost neutral.

Each day I wear both the trader hat and the investor hat. It is all about time frames, and I am trying to do an honest appraisal in the weekly look ahead.

We traders will face a challenging week, with cross currents from data, sentiment, earnings, and options expiration.

Comments

Jeff,
If I agree I hope that doesn't mean that you DON'T learn?
I tend to look at markets in a similar way to you and hence we often come to very similar opinions and processes. What struck me here most was your points about investors needing to control risk whilst still participating. My risk measures are a function of price action in relation to value so I can see where risk at an individual level is - and - by extension - where it is at a sector or market level. If you look at Citi, for example, the value in the stock is still rising - suggesting that it is an investable stock - but the risk premium you were paying to value was higher than at any time since October 2009 - so it was a risk accident waiting to happen (value is at 4.38 now, so rising support from there will give you a chance to reenter the stock relatvielty soon.) This kind of awareness of stock level risk is what is needed to be able to stay invested. Apple, incidentally is already an opportunity on this same basis. To control risk it is important to be able to quantify it at least - that is the directino that research needs to go I suspect.
anyway - a good read as ever

Ken -- What can we learn if all of our discussions are with those with whom we agree? I spend a lot of my time reading articles from those with a wide range of viewpoints. I embrace disagreement, and always try to follow where the data lead.